When US Federal Reserve Chairman Ben Bernanke on 22 May suggested that quantitative easing, or QE, could be eventually phased out under certain circumstances in the not too distant future, turmoil broke out in the financial markets, lasting until late June. ...
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Mikio Kumada, Global Strategist at LGT Capital Management
Emerging markets equities were particularly hard hit. But should we really “blame” EM weakness on the potential tapering? And would a Fed taper really be such a bad thing?
Who is to blame for the weakness of emerging markets?
The tapering concerns have clearly subsided over the past weeks. The S&P 500 is trading 6.8% higher than on 22 May and the EuroStoxx is up 7.6%, but the MSCI Emerging Markets Index is still underperforming, trading about 5.4% lower. Can we really blame EM weakness on tapering – and EM strength on non-tapering? There are a few reasons that suggest otherwise:
1) EM equities began to lose relative strength in the fall of 2010, long before there were any tapering fears. During that time, QE was extended and intensified three times – without having any positive effect on EM relative performance. Why should the reversal of QE have the opposite effect?
2) The tapering-induced market turbulence (22 May-24 June) is hardly visible in the bigger relative trend picture and therefore potentially meaningless. Bernanke’s speech didn’t mark the beginning or any new phase in the trend.
The emerging world’s problems are mostly endogenous
So who should be “blamed” for the continued EM anemia? The most plausible answer is that the “culprits” are to be found within the emerging market universe itself, with the main suspect being China:
1) The longer-term EM underperformance (since the fall of 2010) coincides with a period of elevated volatility in China’s money market – a byproduct of a Chinese policy that seeks to discipline and improve its banking and credit risk management system. Above all, however, it is a consequence of excessive credit growth in China since 2008.
2) The shorter-term market action during the tapering-turmoil in May/June shows that EM performance actually improved right after Bernanke’s speech. It deteriorated only after China’s money market interest rate began to surge on 5 June, from 4.6% to 12.9% by 20 June. China’s money markets calmed down by the end of the month, by which time EM performance had stabilized again.
Fundamentally, tapering would be a welcome development
Being conditional on a considerable brightening of economic activity, tapering would actually be good news – and event that won’t happen if the economy can’t take it. Still, the role of US monetary policy is overrated with regards to the EM. The key trends in the EM primarily depend on endogenous developments. China, the world’s second-largest economy, is of particular importance. Doubts remain that China’s post-2008 credit excesses have not yet been sufficiently digested to allow the world’s second-largest economy to return to steady and sustainable growth – and as long as that is the case, EM relative weakness might continue. At the same time, any US tapering is likely to be moderate, while last week’s unexpected events (the European Central Bank cut rates and the Czech central bank announced an exchange rate floor) remind us that global monetary conditions might be even more accommodative in the future than they are today. In any case, the developments of the recent years show that QE in the developed economies does not automatically benefit the emerging markets – it primarily benefits the home countries, which is, of course, intended. Consequently, QE withdrawal will not necessarily need to hurt the emerging markets. Tapering, when and if it happens, might even help restore more “normal” conditions in global markets – i.e. conditions in which the emerging markets tend to naturally outperform their developed counterparts.
Source: ETFWorld – LGT Capital Management
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